Opinion: Now is not the time to squeeze the brakes on Indian equities

As Indian equities come off the peaks from the start of the year, some emerging-market investors are cautious about future prospects.

Our view, however, is that the current investment environment, coupled with some home-grown drivers, could spur on the Indian equity market to provide even more opportunities than before.

There are plenty of reasons to be sceptical about the prospects for Indian equities, but we remain resolutely positive based on India’s compelling prospects. Projected economic growth of an average 7.3 percent between 2018 and 2022 indicates that the success story shows no signs of ending soon.

We see the economy being able to shake off the effects of the recent global equity sell-off, the Goods and Services Tax (GST) introduced last summer, and the sudden demonetisation programme in late 2016. These developments temporarily affected cash-intensive industries and supply chains – especially with regards to small traders supplying to larger companies – as they found it difficult to meet the new paperwork demands placed on them.

As these effects begin to wear off, we think there is more room for Indian equities to potentially appreciate. Despite some outflows from last month’s global equity sell-off and the recent $1.8bn Punjab National Bank (PNB) scandal, we believe India’s favourable demographic backdrop could lead to more growth in the equity market, particularly in large-cap stocks.

Demographic argument

Domestic demand now accounts for the largest proportion of the Indian economy and is driven by the burgeoning middle-class population.

It’s not the first time we’ve noted the rise of the middle-class, and it won’t be the last – the population expansion is only in its initial stages and some estimates projected it to double in size from the current 1.35 billion within the next eight years.

In our view, favourable macroeconomic and demographics factors should lead to income growth, which should help further drive domestic demand. We also see savings likely to grow.

We’d expect companies in the consumer discretionary sector to thrive on the back of India’s growing middle-class population, with people striving to upgrade items such as cars, jewellery and designer clothing. And with this progression, upgrading non-essential items, such as air conditioning units and electronic gadgets, may become consumer priorities as disposable incomes rise.

Banking on change

Given rising disposable incomes among the country’s rising middle class, we anticipate a growing demand for credit and investment services and, as such, see potential investment opportunities within the private retail banking industry, since public-sector banks have been focusing on improving asset quality, which has restricted their ability to compete in the retail space.

As state-owned banks have found themselves weighed down by debt and the alleged PNB scandal, it has highlighted the deficiencies in how state-owned banks are managed.

We believe real improvements in public-sector banks have yet to be seen, which will likely accelerate the shift in market share towards private-sector banks. We think investors are realising that strong balance sheets and the adoption of advances in technology could help private banking gain an even larger share of the market.

Property growth

Likewise, the middle-class population has boosted demand for better quality housing, which we expect should be positive for housebuilders and real-estate management companies. These companies tend to be positioned in the mid- to large-cap area of India’s equity market.

Regulatory changes implemented in May 2017 have begun to transform the property development sector, but we think there’s more to come. In the 2018-19 February Union Budget, Finance Minister Arun Jaitley suggested that an affordable housing fund would aim to provide housing for all citizens by 2022 and allow better access to major cities through the availability of urban properties.

We feel this initiative is welcome, but we think the government left the door open to supporting the urban middle class. That said, if additional incentives were implemented it might accelerate urban home construction and kick-start growth in jobs in the semi-skilled sector.

Despite this, we’d still expect to see a pick-up in capital expenditure (capex), particularly in India’s real estate sector. We’ve been seeing a downtrend in capex for some time, but expect to see growing demand for better-quality housing and goods spark a rebound.

Don’t fear the tax

The government also announced it would reintroduce a 10 percent long-term capital gains tax and apply it to any sale of equity shares over 100,000 rupees. The change, in our view, should not present a kneejerk reaction in Indian equities due to the clause that exempts capital gains tax on sales up to January 31, 2018.

In our view, there’s more to come for the Indian equity market as it adjusts to the effects of the Union Budget. Despite some investor trepidation on India’s equity market run, a combination of favourable macroeconomic and demographic factors could well make room for higher valuations.

India’s bounceback

India’s growth in H1 2017 fell to a three-year low of 5.7 percent after two painful measures were introduced. In November 2016, Prime Minister Narendra Modi abruptly banned its two largest currency notes, leading to a sharp slump in India’s cash economy.

An overhaul of the tax system in July last year also disrupted business, as companies adapted to the new regime. However, growth rose to 7.2 percent in Q4 2017, and the IMF predicts it will finish 2018 on 7.4 percent.